By Claudia Hirsch

NEW YORK (MNI) Philadelphia Federal Reserve Bank President
Charles Plosser Friday said the Fed must be careful not to fall “behind
the curve” on inflation.

“I worry about us being behind the curve,” Plosser told reporters
following a luncheon speech at a Shadow Federal Open Market Committee
event.

“I don’t think that is necessarily imminent but I think we have to
be very careful.”

If inflation and inflation expectations step up, it will be “harder
to get the cat back in the bag,” the Philadelphia Fed president said. “I
want to make sure that doesn’t happen.”

Earlier, he told his audience that oil prices themselves won’t
spark inflation, but keeping monetary policy “easier, longer” in
response to energy costs would.

“The reason that oil prices worry me is because there’ll be more
pressure to keep monetary policy easier, longer,” he said. To do that
would “ensure that it generates inflation.”

Pointing to 1970s era of dramatic inflation in the U.S., Plosser
said, “It wasn’t the oil prices per se, it was the reaction of the Fed
to the oil prices … which ultimately generated massive inflation.”

Regarding the exit strategy from the latest round of quantitative
easing, Plosser told reporters it was too soon to tell if the current
plan to purchase up to $600 billion in government debt by the end of
June should be curtailed early.

“If inflation expectations begin to look like they’re getting away
from us, then we need to change course,” he said. “So it will depend a
little on how things evolve in the next few months.”

Earlier, answering audience questions, Plosser said that during the
eventual exit from quantitative easing, the asset “runoff” should be
smooth, and that the runoff rate must be as predictable as possible.

Having detailed his own specific plan of exit in his midday speech,
Plosser told reporters he doesn’t believe the that the Fed selling
certain assets from its recession-bloated balance sheet would crowd out
other assets in the market.

“As the economy recovers, it’s not going to be an issue,” he said,
because market demand will naturally grow.

“We wouldn’t start this cycle until we thought the economy were
improving,” Plosser said. “I’m more sanguine that the markets are going
to be fine.”

As to whether would-be home buyers could withstand higher mortgage
rates in the event of the Fed’s selling its mortgage assets, Plosser
said, “If the economy is improving, and we’re at a stage where we are
exiting, then long-term rates will be rising independent of what we do.”

He said higher long-term rates are “almost inevitable of a cycle
when you come out of recession.”

Plosser said he’s “not too worried” that the Fed’s sale of assets
will overly affect the pricing of other assets. The Fed’s sales will
likely have far less impact on the financial markets, which are now
fully functioning, than the Fed’s recession-era purchases had on
then-dysfunctional credit markets, he said.

With his detailed exit-strategy plan, Plosser said, he hopes to
“stimulate thought and discussion.” He said the Fed is “thinking hard
about” its exit plan.

He also told his audience that headline inflation – not core
inflation, which excludes volatile food and energy components – is the
most important price gauge to monitor.

“That’s all that matters at the end of the day what consumers
pay,” he said. “Core only matters to the Fed … to the extent that it
helps predict headline inflation over a reasonable horizon.”

And Plosser said the core inflation figures don’t do a very good
job at predicting, either.

Finally, turning Europe’s sovereign debt crisis, which most
recently delivered a downgrade in Portugal’s debt rating by Fitch and
S&P, Plosser told reporters Europe will “muddle through … probably.”
If not, however, the “ripple effects” of failure would likely have a
greater impact on the U.S. economy than current oil-price spikes and
Japan’s earthquake, tsunami and nuclear crisis.

** Market News International New York Newsroom, Tel. 212-669-6430
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